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Emerging Markets

The new world: a map of emerging markets

Delphine Arrighi argues that some of the countries which suffered most during 2018 may prove good value in the future.

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Emerging markets have been under pressure in 2018. Uncertainties over the trade war between the US and China exacerbated an already difficult environment. Global liquidity tightened as the US Federal Reserve (Fed) unwound quantitative easing and accelerated the pace of interest rate hikes.

The stronger US dollar has put all emerging markets currencies under strain despite their relatively sound fundamentals. Countries with large current account deficits suffered more than others. Argentina and Turkey took drastic measures to curb their macro-imbalances and halt currency depreciation. But even oil exporters weakened, despite improving fiscal and current account balances, as the market ignored the rise in oil prices and focused on fears of a global slowdown.

Now those fears are spreading across other asset classes and, ironically, could bring about the policy changes emerging markets need to outperform again. Much will hang on the trajectory in 2019 of the trade dispute between the US and China. China has already slowed. If Wall Street and the American economy suffer, Trump will come to the table. Meanwhile, a more divided US Congress reduces the chance of further fiscal stimulus, which could eventually slow US growth, reprice future Fed hikes and ultimately end the strong dollar cycle.

That could provide the external conditions needed for emerging markets to rebound, as beaten-up valuations and sound domestic fundamentals lure investors back. However, differentiation will remain key because countries with high refinancing needs will struggle in a world of reduced global liquidity. We therefore remain true to our investment approach, based on a deep understanding and close monitoring of domestic economic fundamentals and politics, to deliver performance in 2019.

ARGENTINA

The Argentine peso halved in value in 2018, but bounced in October after a change in the central bank’s monetary targets. The sharp devaluation is forcing a rapid narrowing of the current account deficit. With a fiscal adjustment of 3% of GDP in a year and its financing needs covered until 2020, issuance should remain limited next year.

VERDICT: could be one of the best credits of 2019

BRAZIL

Although a socially divisive figure, new president Jair Bolsonaro has convinced the market that he is Brazil’s best economic option. Hence the strong rally across Brazilian assets. We continue to see value in the curve, given the lack of inflationary pressures and potential for significant fiscal turnaround.

VERDICT: vulnerable to political risk

INDONESIA

The authorities have taken action to keep the current account deficit within 2% of GDP and reiterated efforts to keep the fiscal deficit below 2% in 2019. There have been multiple pre-emptive rate hikes to defend the rupiah. Inflation is well contained and comfortably within targets.

VERDICT: attractive for 2019

MEXICO

While the central bank may hike rates to support the peso, we think risks remain tilted to the upside. The president-elect’s policies could trigger more substantial outflows from a very overweight offshore community in the local bond market.

VERDICT: could be past the worst

TURKEY

In September the central bank hiked the main repo rate to 24% from 17.75%, which stemmed the rout in the lira. The sharp slowdown in growth should also help rein in inflation in 2019 and curb imports, with the current account deficit already adjusting rapidly after the currency devaluation.

VERDICT: overweight

ZAMBIA

One of the worst performers of 2018. Pressures keep on building on the kwacha and domestic interest rates, raising question marks over the government’s ability to fund its fiscal deficit. However, market fears that Zambia will default may prove overly pessimistic, given its ability to refinance its bilateral loans with China. The next eurobond maturity date is not until 2022.